Straining the FHA's umbrella

A District nonprofit organization that says it helps cash-strapped homeowners avoid foreclosure is under federal investigation for instead helping lenders make high-risk loans that leave the government on the hook if they go bad, according to sources familiar with the probe. Federal officials say they are concerned that the Rainy Day Foundation could be thwarting government efforts to weed out mortgage lenders that make too many precarious loans.

The Federal Housing Administration, which encourages homeownership by guaranteeing mortgages made by qualified lenders, has long struggled to keep companies from slipping risky loans under its protective umbrella. The agency has done this in part by barring lenders if too many of their borrowers default.

The Rainy Day Foundation advertises that it can help lenders remain in the FHA's good graces. For a fee of about $600 per borrower, paid by lenders, home builders and real estate firms to cover the cost of making mortgage payments for distressed borrowers, the group promises to limit defaults during the two years after a loan is made, the period watched most closely by the FHA. Rick Del Sontro, chief executive of the Rainy Day Foundation, said in an interview that his group provides an important service to borrowers and lenders.

But some lenders and housing experts say this kind of "payment protection program" postpones rather than prevents defaults and allows lenders to make riskier loans.

The Justice Department has alleged, for instance, that the Rainy Day program was used by a major FHA lender, Lend America, in an attempt to conceal fraud. In a civil lawsuit filed against Lend America in October, the Justice Department charged that the company secured FHA guarantees for loans based on fraudulent underwriting, then paid Rainy Day to hide defaults by some borrowers. The suit said that the FHA is likely to lose millions of dollars as the borrowers eventually default.

"The purpose of the Rainy Day Foundation was and is to conceal borrowers' inability to keep up with mortgage payments during the first two years of the loan, the period of time that HUD monitors its Direct Endorsers' delinquency and default rates," the suit said. "Rainy Day purports to be a financial counseling program but on information and belief it is a mortgage lender-funded slush fund."

The Justice Department, which sought to keep Lend America from making more FHA loans, won a permanent injunction against Lend America in December. HUD withdrew the firm's FHA approval the same month. Lend America, which is no longer in business, repeatedly denied the Justice Department's allegations that it defrauded the FHA.

The Justice Department is conducting an investigation into the Rainy Day Foundation, according to sources familiar with the matter. They declined to speak on the record because the investigation is ongoing.

According to federal tax rules, a tax-exempt nonprofit such as the Rainy Day Foundation cannot be operated for the benefit of private interests or shareholders, and earnings must be reinvested in the charity. But employees of the group can benefit from fees it collects through pay and other compensation.

Rainy Day's marketing materials tell lenders that its mortgage payment protection helps reduce delinquencies and "assists in managing HUD Neighborhood Watch statistics," the official default figures maintained by the Department of Housing and Urban Development. The FHA is part of the department.

Officials at HUD are disturbed by this marketing, said a source familiar with HUD's concerns. The source said the department is now studying payment protection plans to determine whether they pose a risk to the FHA's insurance fund, which is used to cover failed mortgages guaranteed by the agency. The source declined to speak on the record because the agency is concerned about discussing the drafting of potential new regulations.

FHA Commissioner David Stevens said in a written statement earlier this year: "I'm deeply troubled at the suggestion that mortgage protection programs are marketed as a vehicle to disguise otherwise risky loans."